Closing the Barn Door Department, Subprime Division

Now that madness in subprime mortgage underwriting has gummed up credit around the world, it's time to protect the market from its own excesses.

Specifically, to compel independent mortgage brokers and other loan originators to take responsibility for making sure that borrowers can afford the loans they are being sold.

Federal Reserve Governor Randall S. Kroszner gave the central bank's imprimatur to the effort in testimony today to Congress. Speaking to the House Financial Services Committee, he endorsed additional legislation—the Mortgage Reform and Anti-Predatory Lending Act of 2007—now working its way through Congress.

"Congress is appropriately concerned about problems in the mortgage market," Kroszner said in prepared remarks. "The Mortgage Reform and Anti-Predatory Lending Act of 2007 takes a comprehensive approach and is appropriately focused on the more problematic practices in the subprime mortgage market."

The numbers speak for themselves, he added. Serious delinquencies among subprime adjustable-rate mortgages rose to almost 16 percent in August, three times the rate in mid-2005. The serious delinquency rate for so-called near-prime, or alt-A, loans has also tripled, to 3 percent from 1 percent a year ago. (By contrast, serious delinquency among prime loans has remained below 1 percent.)

Predictably, higher delinquency rates are translating into more foreclosures. About 320,000 foreclosures were initiated in each of the first two quarters of this year, up from an average of about 225,000 during the past six years, Kroszner said.

A disproportionate number—more than half—are subprime mortgages, particularly adjustable-rate subprime mortgages approved just before the housing market cooled, Kroszner said. Some slipped into default after only one or two payments—or no payment at all.

Part of the fault for this lies with the rapid growth in the number of unregulated brokers and other loan originators. Kroszner said lenders that are not subject to oversight by a federal banking agency originated almost half of the higher-priced conventional first mortgage loans reported in 2006.

"Abusive or fraudulent lending practices" at many of these unregulated lenders resulted in homeowners "taking on mortgage obligations they could not afford, with terms they may not have fully understood," he added.

A key section of the bill before Congress would hold securitizers—the banks that create bond-like securities based on bundles of mortgages—liable for the actions of mortgage originators.

While expressing support for the bill, Kroszner was careful to caution that "it is important that new laws carefully target lending abuses without unduly restraining responsible lending."

"Getting this balance right is particularly critical now," he noted, "as many borrowers facing rate adjustments may need to refinance into more affordable loans."

by Mark Stein

A House of Representatives press release describing the bill can be found here.

Text of the bill can be found here.